Taxability of Canceled Debt

Taxpayers often question the taxability of canceled debt because they did not receive money in hand. In situations where property is surrendered, such as a foreclosure, they feel that by giving up the property they are relieved from any further obligation. You will need to explain that the benefit to the taxpayer is the relief from personal liability to pay the debt. Information in Publication 17 can assist you with the explanation.

Additional resources include:

• Publication 523, Selling Your Home
• Publication 525, Taxable and Nontaxable Income
• Publication 544, Sales and Other Dispositions of Assets
• Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
• Publication 4731-A, Screening Sheet for Foreclosures/Abandonments and Cancellation of Debt

Generally, when debt is canceled the lender will issue Form 1099-C, Cancellation of Debt, which is then reported by the recipients on their tax return. There are exceptions and exclusions to the general rule that determines whether a canceled debt is included in income. This is covered later in this course.

These publications and other resources can be found in the References Tab at the top of each screen.